Socket Mobile, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Socket Mobile designs and sells mobile data-capture products, primarily Bluetooth barcode scanners used with smartphones, tablets and business applications. Results are unaudited.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $5.62 million | $5.04 million | Up 11% |
| Gross profit / margin | $2.91 million / 51.8% | $2.51 million / 49.7% | Margin up 2.1 percentage points |
| Operating expenses | $2.24 million | $1.91 million | Up 18% |
| Operating income | $668,000 | $600,000 | Up 11% |
| Income before taxes | $638,000 | $556,000 | Up 15% |
| Income tax expense | $253,000 | $8,000 | Increased substantially |
| Net income / diluted EPS | $386,000 / $0.05 | $548,000 / $0.09 | Net income down 30% |
| Operating cash flow | $241,000 | $91,000 | Improved |
Gross-margin improvement reflected supplier component-cost reductions associated with higher scanner volumes. Net income fell despite higher operating income, mainly alongside the increase in tax expense; 2017 tax expense included approximately $240,000 of deferred tax expense and $13,000 of alternative minimum taxes. Basic EPS was $0.07 versus $0.10. Diluted weighted-average shares rose to 7.77 million from 6.50 million.
Revenue and operating trends
- Cordless barcode scanners and accessories generated $5.55 million, or 99% of revenue, up 39%. Growth was attributed primarily to SocketScan 800 Series and 7 Series scanner sales.
- Mobile handheld computer, accessory and license-fee revenue was $14,000 versus $868,000. The SoMo product family was phased out in 2016 due to component obsolescence. Service revenue declined to $59,000 from $170,000.
- U.S. revenue was $4.34 million; Europe was $1.10 million; Asia and the rest of the world was $181,000. Revenue from Europe increased year over year.
- Research and development expense increased 21% to $797,000, mainly due to personnel and product-development costs. Sales and marketing rose 11% to $759,000. General and administrative expense rose 22% to $689,000, including higher legal, professional, listing and facility costs.
Liquidity, debt and obligations
Cash and cash equivalents were $1.62 million at March 31, up from $1.32 million at year-end. Current assets were $7.36 million and current liabilities $3.80 million. Operating cash flow was positive, while higher receivables and inventory were significant uses of working capital. Investing activities used $84,000, principally for equipment; financing activities provided $146,000, primarily from stock-option exercises.
The company had no bank-line borrowings at quarter-end. Its revolving facility permits up to $2.5 million, with approximately $1.654 million of borrowing capacity reported as available, subject to eligible receivables, bank discretion and a minimum quick-assets-to-bank-obligations ratio of 1.75:1. The domestic line was extended to February 2019; the international line expires in February 2018.
Current related-party convertible notes totaled $752,625, with approximately $411,500 of accrued interest. The notes are secured by company assets, bear stated rates of 8% or 12% (one tranche previously bore 18%), and are convertible at $1.25 per share. One tranche has a holder call provision and matures September 2017. Capital-lease liabilities were approximately $73,000. Contractual obligations included $3.381 million of inventory purchase commitments and $2.454 million of operating lease payments; the office lease runs through June 2022.
Accounting, outlook and risks
- Revenue recognition change: The company adopted the new revenue standard effective January 1, 2017. It now recognizes distributor sales when shipment is completed and title transfers, net of estimated returns, rather than deferring all revenue and cost until distributors sell through inventory. The adoption produced a one-time $503,000 improvement in opening retained deficit, net of tax. The filing reclassified year-end distributor balances into a $2.010 million refund liability and $948,000 deferred-cost asset.
- Management outlook: No specific revenue or earnings guidance was provided. Management expected moderate R&D expense increases in coming quarters, sales and marketing expense to remain flat for the balance of 2017, and G&A to decline moderately in Q2 and then remain flat. The Contactless SmartTag Reader Writer D600 was described as expected to be available in 2017.
- Tax assets: The company had $9.017 million of deferred tax assets, including $7.824 million of net operating loss carryforwards. Their realization depends on future taxable profitability; future ownership changes could limit use of tax losses.
- Concentration and execution risks: Ingram Micro represented 45% of Q1 revenue and 59% of receivables. The top three distributors generated about 74% of revenue. A limited number of suppliers accounted for 60% of inventory purchases. Risks also include distributor returns and inventory movements, component availability, product-development and market-acceptance uncertainty, competition, and quarterly order timing.
- Other matters: The company reported no material legal proceedings and no off-balance-sheet arrangements. It identified foreign-exchange exposure; a hypothetical unhedged 10% adverse exchange-rate movement was estimated to reduce Q1 net income by about $39,000. Disclosure controls were concluded effective, with no material change in internal control reported.
Important facts for investors to verify
- How the new distributor revenue-recognition policy and return estimates affect reported sales, liabilities and comparability with prior periods.
- Whether scanner sales growth continues and offsets the discontinued SoMo product and declining service revenue.
- Distributor and receivables concentration, channel inventory, return exposure and collection trends.
- The September 2017 note maturity and holder call terms, accrued interest, conversion dilution, and continued compliance with bank-line covenants.
- Whether future taxable profits support realization of the $9.017 million deferred tax asset.
- Execution of product-development plans amid supplier concentration, purchase commitments and the company’s stated operating-cost expectations.